Dollar Tree Earnings Were Great But Profit Guidance Led to an Unusual Put Trade

Dollar Tree (DLTR) released excellent earnings today for the fiscal Q4 ending Jan. 29. But that's ancient history to the market. It is more focused on management's tepid guidance going forward, including lower earnings for the next fiscal year. This is despite more of its store lapping the “break the dollar” to an average of $1.25 per item. 

As a result, one large investor bought a massive put option at the money (ATM) today. This signals they expect much lower earnings for its fiscal Q1 and a significant drop in the stock price.

Here are the details. Barchart's Unusual Stock Options Activity Report showed that an investor bought 9,000 puts at the $145 strike price for the period ending May 19. They paid $5.15 for those puts, so their break price is below $140 per share (i.e., $145-$5.15=$139.85). That represents a minimum drop in DLTR stock, which is trading up today at $147.05, or  4.90%.

The reason this is important is that the number of options bought at this strike price massively dwarfed the existing options contracts outstanding.

The table from Barchart seen above shows that the 9,012 in volume today is 6.46x the existing number of put options outstanding. For example, this means that the investor paid $4.635 million, i.e., $5.15 x 9,000 contracts x 100 shares per contract. Why did they do this?

For one, there is a good deal of leverage in this trade. Let's say they expect the stock to move to $130 on or before May 19. That represents a drop of $17.05 from today's price, or 11.6% lower. That means the investor would make just 11.6% if they had decided to short the stock instead. The advantage here is that by shorting there is no deadline like May 19 for the short to work out.

But by buying puts, the investor has a strong conviction DLTR stock will falter by the time its Q1 earnings are released. This implies that the put trade will be in-the-money by $9.85 per put option on or before then (i.e., $139.85 breakeven -$130 target price). That means that the price of the options will be at least $9.85 per put, or 91.3% over the price paid, $5.15. In fact, due to extrinsic value on top of this intrinsic value, the price of the put will likely be well over twice or double the $5.15 paid.

Will DLTR Stock Falter By Q1?

Dollar Tree earned $7.21 during fiscal 2022 (ending Jan. 29). However, today the company came out with earnings guidance of just $6.30 per share to $6.80. That represents a decline of about 10% at the midpoint of $6.55 in earnings per share (EPS).

Moreover, that means DLTR stock is trading at a high P/E multiple of 22.5x (i.e., $147/$6.55). Moreover, analysts have not yet adjusted their earnings estimate, as the average of 12 analysts surveyed by Barchart is $7.75 EPS and $7.22 from 25 analysts surveyed by Seeking Alpha.

And, frankly, the lower earnings guidance by the company does not look good given that many more of its stores are lapping the “break the dollar” price point. The company said its average price point is now $1.25 per item. So that should have led to higher earnings and this isn't showing up in management's guidance. 

That implies they expect lower volumes, lower demand, and much more resistance or price elasticity of demand from the higher price points. In the end, this could lead to a lower stock price if that plays out this year. But as I have pointed out in other unusual stock options articles, there are risks here.

Nevertheless, keep in mind that this huge put trade is a massive contrarian play by the investor. They could be just doing this to hedge out other parts of their portfolio, and not as concerned if the trade makes a profit, as long as it acts in a contrarian way to the rest of their portfolio. So buyers should beware of copying this trade.

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